Trader Talk

BlackRock is in a robo-advising arms race and investors are the winner

Active manager blues?
Active manager blues?

In 1997, when I first came to the NYSE, there were 5,000 people on the floor of the New York Stock Exchange — today there are about 450. That is directly due to technology.

This illustrates an important point about the BlackRock story today: there is a technological arms racing going on between asset managers, and the average investor is the beneficiary.

At the NYSE and other trading platforms, it was about the ability to create computer programs that were able to trade stocks at intervals far faster than humans could do so.

For BlackRock and other asset managers, it's about the ability to create computer programs out of decades-old investment methodologies. Call it value investing, or growth investing, or momentum investing, whatever: thanks to advances in big data analytics and machine learning these investment styles can be put into algorithms.

And just like a lot of the NYSE traders have gone away, so a lot of the active managers are going away.

That's what will likely happen to actively managed stock pickers. In ten years, they won't be gone, but there will be fewer of them around.

All asset management firms that have any kind of active management have suffered from the inability to outperform the market. As a result, money has flowed from more expensive actively managed funds to less expensive passively managed funds, and more generally from mutual funds to Exchange-Traded Funds (ETFs), which for the most part are passively managed.

BlackRock is just acknowledging this reality, along with the reality that technology is a very important tool for investment selection.

The problem, of course, is that these actively managed funds generate big fees, so this trend has been a problem for firms that are associated with active management. The stocks of these companies have suffered this year:

Asset managers in 2017

Waddel & Reed down 13.0%
Piper Jaffray down 12.7%
T. Rowe Price down 9.1%
Federated Investors down 8.1%
Janus down 2.6%
BlackRock flat

BlackRock is flat because it has iShares, the number one ETF family, and is rapidly growing assets. iShares is basically a passive franchise: only a small percent of its assets under management are actively managed.

There is a whole subclass of quantitatively managed ETFs out there now. You can call it "smart beta" if you want to, but they all use rules-based methods.

This is just the application of decades-old methodologies that are being spun into computer algorithms. Legendary investors like Bill Miller at Legg Mason always insisted that they were successful because they weighed information differently than others. Maybe. But at heart, a Bill Miller was a "value" investor who used a combination of fundamentals, management insights, and capital allocation to come to a conclusion on what a company was worth.

All of these metrics can now be computerized and placed in an algorithm.

An "iShares by Blackrock" sign on the front of the New York Stock Exchange.
Richard Levine | Corbis | Getty Images

For the past couple years, Goldman Sachs has offered a series of ETFs that are based on quantitative investment strategies. Its ActiveBeta Large Cap ETF picks stocks based on a combination of value, quality, momentum, and low volatility. These are four criteria that are widely used by professional stock pickers. The difference is that this process is computerized.

There's an even bigger difference: cost. Whereas many actively managed funds charge 1.0 percent or more per year, the GSLC charges 0.09 percent. By comparison, the world's biggest ETF, the S&P 500 SPDR ETF, also charges 0.09 percent.

Think about that: you can buy a quasi-actively managed fund from Goldman for the same price you buy the S&P 500.

That is a compelling value proposition, and that is why the industry is moving in this direction.

BlackRock is doing it as well: they too have a multi-factor ETF, the iShares Multifactor ETF , that focuses on quality, value, momentum, and size, that also charges a relatively low 0.20 percent.

BlackRock and Goldman will not necessarily use identical models, of course, but you get my drift.

All this is good news for investors. Fees are declining, and advances in machine learning and big data analytics has put advanced research tools (like CNBC partner Kensho) into the hands of everyday investors, tools that were only available to advanced shops like Renaissance and Citadel 10 or 15 years ago (don't kid yourself: they still have a big advantage because their data sandboxes are much bigger, but the gap is definitely narrowing).

Where is all this heading? What's the end game?

The simple way to look at this is that the asset managers who are competing for our money are in a technological arms race. Software is better at pattern recognition and sniffing out relationships between stocks that can be used to generate outperformance.

However, these pockets of outperformance will get smaller as the data becomes available to larger sets of investors. These programs, over time, will keep squeezing ever-smaller inefficiencies out of the market, and the BlackRocks and Goldmans will keep competing to squeeze out those inefficiencies.

So what's the bottom line? Think about this comment from my friend Matt Hougan, CEO of Inside ETFs: "In 10 years, the idea that we trusted human beings to pick stocks will seem absurd, just like the idea that we trusted humans to drive cars will seem absurd."

I think this is a bit strong: stock pickers won't disappear, but like NYSE floor traders, there will be fewer of them.